PRC 4: INTRODUCTION TO ACCOUNTING
Chapter 5
PRUDENCE CONCEPT:
According to prudence concept,
Every anticipated loss should be recorded
Income will only be recorded when it is certain or,
Assets should not be overstated
Labilities should not be understated
DEBTS:
Good Debts:
It is an amount owed by a customer that the business believes it will have no difficulty in
collecting from the customer. The good debts do not require any special accounting treatment
unlike bad and doubtful debts.
Bad Debts:
It is the part of receivable that the business believes it will never be able to collect. This may arise
due to bankruptcy, death or dishonesty of a customer. This is a loss to business and, therefore,
shall be written off as an expense. The receivable is also removed from the accounting records.
Doubtful Debts:
It is an amount owed by a customer that the business believes might prove difficult to collect but
still hopes to collect it. For example, a disputed invoice with the customer or past experience that
some customers might not pay.
Instead of writing off the debt which would remove it from the records, a business sets up an
allowance account. The receivable must stay in the accounting records so that the business
continues to chase payment.
Recovery of Bad Debts:
A bad debt written off may be recovered subsequently. For example, a customer pays when his
financial conditions are improved. This may be recorded in either of the following two ways:
Reduction in bad debts expense
As income (bad debts recovered)
Example: 1
On 1st January 2021, Maula Jatt Limited had receivable balances of Rs. 25,000. During the year
ended 31st December 2021, following details relate to customers.
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Credit sales of Rs. 40,000
Cash sales of Rs. 80,000
Credit Sales Return Rs. 2,000
Amount received from credit customers in cash Rs. 15,000
A customer was declared insolvent who owed Rs. 3,000. The amount is written off.
Amount received from customers Rs. 5,000 for a debt which was written off in 2018.
A customer has filed for bankruptcy who owed Rs. 8,000. It is expected that 25% of the
amount is expected to be recovered.
Required:
Journal entries of all the above transactions and ledger accounts of “Receivables”, “Provision for
doubtful Debts” and “Bad & doubtful debts expense” for the year ended 31 December 2021.
Example: 2
On 1st July 2021, Noori Natt Limited had receivable balances of Rs. 150,000. During the year
ended 30th June 2022, following details relate to customers.
Credit sales of Rs. 120,000
Cash sales return of Rs. 8,000
Amount received from credit customers in cash Rs. 75,000
A customer has escaped who owed Rs. 5,000. The amount is written off.
A customer who owed Rs. 20,000 is has filed for bankruptcy. It is expected that only Rs.
5,000 is expected to be recovered.
Bad debts recovered from a customer Rs. 1,000 which was written off last year.
Required:
Journal entries of all the above transactions and relevant ledger accounts for the year ended 30 th
June 2022.
Provision/Allowance:
The provision/allowance account is a contra asset account and is a credit balance which is then
set against the carrying amount of the receivables in the statement of financial position.
Allowance may be:
Specific (for specific disputed/difficult debt); and/or
General (for receivables excluding bad debts, good debts and specifically provided for).
The allowance account is estimated periodically and any adjustment is recognized either as an
expense (in case of increase) or as reduction in an expense (in case of decrease).
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AGING ANALYSIS
Preparing an aged receivables analysis is a method of attempting to assess the likelihood of bad
debts or to assess doubtful receivables. This may be an analysis for each individual credit
customer for specific allowance calculation or it may be an analysis of total receivables for
general allowance calculations. The older the age of debt, the more uncertainty in collection
arises.
Example: 3
Laal Singh Chadda creates allowance for doubtful debts after considering the length of time the
debt remains outstanding. He has provided following data as at 31 st December 2021:
Receivables Days outstanding Allowance required
100,000 Less Than 30 Days 0%
70,000 30 to 60 Days 1%
50,000 60 to 90 Days 2%
30,000 More than 90 Days 5%
Required:
Calculate closing provision for the year.
Example: 4
Flowers Limited is in the process of finalizing its financial statements for the year ending
December 31, 2020. Closing balance of the debtors is amounting to Rs. 175,000 which include
good debtors amounting to Rs. 15,000. Following information is related to its doubtful debtors:
Debtors Closing Balance (Rs.) Provision required
Sunflower 7,000 100%
Lilly 5,000 50%
Rose 8,000 20%
Jasmin 5,000 10%
Company has the policy to maintain general provision of 5%.
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Required:
What will be the closing balance of provision for doubtful debts?
Example: 5
Friends Limited has the following information related to its doubtful debtors:
Debtors Closing Balance (Rs.) Provision required
Chandler Bing 72,000 5%
Monica Geller 25,000 20%
Rachel Green 12,000 50%
Joey Tribbiani 5,000 100%
Closing balance of the debtor’s ledger is amounting to Rs. 730,000 including all the above
doubtful debtors. The closing balance also includes a debtor “Ross Geller” owing a balance of Rs.
16,000. Ross is a good customer and always pay on time. Company has the policy to maintain
general provision of 2%.
Required:
Calculate the closing balance of provision for doubtful debts.
PRESENTATION IN FINANCIAL STATEMENTS
The relevant extracts of financial statements are as follows:
Statement of profit or loss (extracts) Rs.
Bad & doubtful debts expense (Note 1) XXX
Statement of financial position (extracts) Rs.
Trade receivables (Note 2) XXX
Less: Allowance for doubtful debts (Note 3) (XX)
Net amount XXX
Note 1: This amount is taken from “Bad & doubtful debts expense” ledger. Alternatively, it may
be calculated as follows:
Bad debts written off + Increase (Decrease) in allowance – Bad debts recovered
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Note 2: This amount is closing balance of “Receivables” ledger.
Note 3: This amount is closing balance of “Allowance for doubtful debts” i.e. total allowance
(specific + general) required at period end.
Example: 6
Honey Limited is preparing its financial statements for the year ending December, 2021.
Following is the relevant information:
Total Sales (60% on credit) Rs. 800,000
Sales Return (50% related to credit sales) Rs. 40,000
Receipts from debtors Rs. 420,000
Bad Debts to be Write off Rs. 10,000
Bad Debts Recovered Rs. 2,000
Opening debtors balance Rs. 140,000
Opening allowance for doubtful debts Rs. 8,000
Out of the closing Debtors amounting to Rs. 10,000 due from a customer with good reputation
and expected to be recovered fully. One another customer owing Rs. 5,000 is facing financial
difficulties and it is expected that 40% amount can be recovered from him.
Company has a policy of maintaining 5% general allowance for doubtful debts.
Required:
Prepare the following ledger accounts:
i. Debtors
ii. Allowance for doubtful debts
iii. Bad & Doubtful Debts
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